Debt settlement and debt consolidation are two great ways of reducing your debt but each have their own benefits and detriments which you should consider before deciding which option to persue. Debt settlement eliminates part of your debts, while debt consolidation reduces the interest rates of your debts. While debt consolidation may have the least amount of impact on your credit score, there are cases when debt settlement is a better choice.
Lower Debt
The goal of both debt settlement and debt consolidation is to lower your debt. Debt settlement companies negotiate with your creditors to reduce the amount of your unsecured debt owed. There will usually be a fee associated with the program that amounts to about 1% of the interest that you would pay if you continue to pay the creditors directly. Debt settlement can reduce your debt from 35% to 70%. A debt settlement program can also cut your payments up to 40% in most cases making it easier to deal with your monthly budget woes. In most situations, a consumer in a debt settlement program is typically debt free within 2-3 years from when they started the debt settlement program. That can be about half the time it would take in a Consumer Credit Counseling Program or a conventional debt consolidation loan to pay off the same amount of debt.
The purpose of debt consolidation is to pay off your high interest debts with a low interest loan. Home equity loans can provide the lowest rates, but after extending the loan over a period of 20 years, the 6% interest being paid on the refinance loan ends up costing the same amount that a 21% interest credit card would. A conventional bank consilidation loan doesn’t actually pay off the debts but rather transfers the debt from one institution to another. This action appears to banks and mortgage companies as a last ditch effort on a consumers part to try and rectify a sinking situation. Many mortgage companies see debt consolidation loans as a sign of stress in your financial situation making it difficult for them to extend you credit in the future.
Credit Score Implication
Reducing your debts through debt settlement is one method to get out of debt in a short period of time relative to your credit history. You credit score will drop, making it hard to qualify for prime lending situations and better interest rates. You can still apply for sub-prime credit after a year has passed, however, the goal of a debt settlement program is to get out of debt, not to create new ones. Taking out a consolidation loan for your debt will have a major impact on your credit score. Since your debt is actually increasing instead of decreasing, you will be negatively hit on your credit report for opening another account making your overall situation more overextended. The majority of consolidation loans are issued with the assumption that the problem debt will be paid off and then the accounts closed. However 98% of consumers that get a debt consolidation loan do not close the problem accounts but rather make things worse by incurring new debt on the paid off accounts. Now the consumer is faced with the debt consolidation loan in addition to the new debt on the other accounts that were previously paid off.
Financial Choices
No single financial choice will fit everyone’s needs. While debt settlement will have an affect on your credit report, additional loans may be too expensive. In extreme cases, debt settlement can help avoid bankruptcy and costly debt consolidation loans. A report from debt settlement companies states that around 50% of the debt that their clients put into the program is from a prior debt consolidation loan.
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